Continual Keynesian Collapse

The Keynesian policy of trying to increase total i.e. “aggregate” demand – either by having government spend, or by cutting taxes just to leave more money in people’s pockets in hopes that they’ll spend – to revive the economy, never works. The latest installment of Keynesian failure is the payroll tax cut.

Predictably, like its predecessors, this “stimulus,” which aimed at putting money in people’s pockets, failed. The economy was unmoved, and indeed appears now to be slowing again, as today’s bleak jobs report underscores.

This wasn’t the first time Keynesian stimulus failed to stimulate. Let’s recall that Keynesianism failed to revive the economy from the Great Depression, during which government spending increased throughout the 30s, yet unemployment remained in double-digits; it failed in 2001 when President Bush attempted to stimulate the economy out of recession by putting money in people’s pockets through a series of tax rebates; it failed under President Bush a second time in 2008, when government spent hundreds of billions of dollars; then it failed in 2009 under President Obama, after we spent the largest sum of money in the name of Keynesianism – some $800 billion – in order to revive the economy. The one thing you can say for Keynesian stimulus is that it is bi-partisan – it fails for Republicans as effectively as it does for Democrats.

Extending the Bush tax cuts for the top two income brackets was certainly no stimulus, either. Nor was it intended to be. No tax rates were reduced. Rather, blocking those rates from increasing prevented a tax hike from weakening the economy further.

The BEA reported that its first estimate of 1Q2011 real GDP growth was 1.8%. This represented a dramatic fall from 4Q2010 growth of 3.1%. . In 1Q2011, this stimulus amounted to about $110 billion on an annualized basis, or about 0.73% of GDP. Given the Keynesian belief in “multipliers”, the result should have been to increase 1Q2011 real GDP growth significantly over that of 4Q2010. Instead, the real growth rate fell, thus providing one more real-world confirmation that Keynesian stimulus doesn’t work.

This is no surprise. Keynesian stimulus policy is built on the assumption that government spending has a multiplier effect through the economy, meaning that $1 spent by government adds more than $1 to total national income. The mistake is in ignoring the fact that in order to raise money for government to deficit spend, government must first remove that money from the private economy through borrowing, resulting in an equal multiplier reduction. The two sets of multipliers cancel each other out. There is no net increase in total demand.

The same logic applies to Keynesian-style tax cuts aimed at putting money in people’s pockets: If government doesn’t increase spending but cuts taxes instead, it still must borrow money from the private economy to finance its current spending levels. Thus, removing money from the economy in order to finance the cuts leaves total demand unchanged.

Nevertheless, while tax cuts to raise aggregate demand are ineffective as economic stimulus, the right kinds of tax cuts can be stimulative. Stimulative tax cuts must lower tax rates on economic activity at the margins – the tax rate on the last dollar earned – as that’s where drivers of the economy make decisions about investment and work effort. And the cuts must be permanent.

For example, if someone’s income is high enough that he or she is subject to the 35 percent tax bracket (currently the highest individual rate), then he or she will pay $35 on the next $100 earned. If that rate is cut to, say, 25 percent, then that person will pay $25 – earning $10 additional dollars – on the next $100 earned. The incentive is then greater to create an additional $100 of wealth.

Though the 2001 tax rebates aimed at raising demand failed to revive the economy, marginal tax rates were cut on individuals. Originally these cuts were to be slowly phased in until 2010. However, in 2003 they were accelerated, and dividend and capital gains tax rates were also cut. That’s when, not coincidentally, the economy took off.

Today, examples of where this type of tax cut would stimulate the economy include the corporate and individual income tax rates, as well as capital gains and dividends tax rates. Cutting any or all of those rates would spur work effort and investment, just as they did in 2003. Of course, given current budget deficits, cutting taxes is especially difficult, which is another unfortunate consequence of the massive Obama stimulus – it made effective stimulus harder to enact. In fact, The Congressional Budget Office just announced that the Obama stimulus actually raised the deficit by $840 billion, far more than originally projected.

Even a payroll tax rate reduction would help, not because it increases families’ cash flow, but because it gives those who have the opportunity to do so more incentive to work and produce. Unfortunately, even this effect was largely erased from the payroll tax cut President Obama championed, because his payroll tax cut was temporary. Temporary tax relief of almost any kind produces few growth benefits.

At what point can we officially put a sword through that argument and bury the concept of a Keynesian fiscal stimulus? Probably until the next recession that occurs during an administration wedded to spending and repelled by rate reductions.

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There's a huge disconnect between the multipliers and their immediate effects on GDP and their lagged effects on things like the unemployment rate. The basic IS-LM framework basically assumes that employment and GDP growth are co-integrated even when the fiscal or monetary shock comes from the government. However, the beneficial half-life of a stimulus is maybe 6 months, but then the more dismal affects begin to show up. A lucky stimulus might get some good results for a few months, but those results are not sustainable in any way unless the rebound is completely organically distributed. That is something that is impossible for a government to orchestrate. The way the unemployment rate is acting now 2 years after Obama's stimulus and 3 years after Bush's spending shock is completely typical if you really look at the data for what occurs after such spending shocks. Now, if we could get a really solid spending contraction, well, then we might be looking at some decent years where the less centralized economy just does what it does best.

Heritage does an extremely good job at times spelling out the dire consequences we are under due to poor federal fiscal policy. This article is one of those analyses. Keynesian fiscal policy is one where a governmental body borrows money for the sole purpose to spark the economy. It can work so long as it is marginal and in areas that are sure to grow a sector of the economy. Take a city center that is run down. There is no money to fix the problem. The government officials, developers, and business owners congregate to discuss what in REAL terms will it take to reinvigorate the city center.

After the discussion, a plan is in place for the construction. Here is where I think governments go wrong. Public funds – be it from taxes or debt – should be limited to basic necessities and the use of the debt to an absolute minimum. All “extras” should come from investors or donators. The government’s role is to ensure the BASIC infrastructure is workable and is sized for growth. Contributors come in with cash to adorn the place – it is a cooperation of both public and private sector interest. I fear that government today puts more emphasis on the “extras.”

The idea is that once the project is complete, profits generated by the increased interest in the area and the willingness of the customer to frequent the revived center will generate tax revenue to pay back the original loan. The plan (not hope) is that the generated revenue from the businesses will increase tax revenue above and beyond the debt and the debt service. All of which should not be so much based projections but hard conservative analysis on the expected outcome of the project.

However, as you can surmise positive Keynesian policy should be used on small projects and should be paid off as soon as possible. I would even go so far as to say Keynesian policies are better fit for local governing bodies and not at the federal level. Otherwise servicing large debts can cause harm and may negate the financial benefits of the injected funding.

The federal workforce provided the core budget that has lead to a $14.3 trillion national debt. Sure, the GDP got a shot in the arm where it would have otherwise gone down from the deficit spending. GDP growth is at an all time low and it is being held up by federal discretionary spending – of which 57% is debt. The debt service at over $450 billion a year dwarfs all federal departments except for the DoD.

Spending at the government level is not efficient as we are spending twice as many dollars paying the average federal worker and we are hiring twice as many workers we need. Construction costs are 10 times higher than what the private sector would spend for similar construction.

The problem with trusting the ignorant self-serving federal workforce with debt money is that they see debt as real money with no limits. They waste the lion’s share of it for personal gain in compensation, pointless personal intellectual pursuits, cushy office spaces and so on. Though Keynesian policy can be helpful for small projects and can marginally boost a local economy – when that project lends to a better infrastructure for profit, the federal workforce uses massive sums of this debt to construct big projects that has no direct o indirect impact on making the private sector stronger. The 2005 BRAC is a primary example. Problem – need to relocate 128,000 federal workers and soldiers to fewer locations. In the DC area, they build seven elaborate luxury office complexes as part of this project – mostly with debt. The total tally is about $35 billion. The replacement for Walter Reed was originally estimated to be $200 million, but turned out to be $2 billion complete with a pointless glassed in atrium large enough to fit the statue of liberty. None of these buildings are profit generators – but quite the contrary, they will house overpaid and over numbered federal workers working on other projects that will also cost 5 to 10 times higher than similar private sector projects. None of these DC buildings had a proper environmental and traffic review and what was provided to the local people was purposely flawed. The driving principal of this project was to reduce the cost to house the hundreds of thousands of new federal workers hired since 9/11 who are now working in leased space. It is clear that after we spend $280,000 to move only one worker in this BRAC there will be no savings to the taxpayer forever. The construction is mostly debt and with the interest, lawsuits and ongoing – never ending – traffic work that will need to be done to address the Army’s incompetence or fraudulent justifications for some of these projects will be costing us more annually then what the rent was originally at each of the current office.

The federal government is out of control. Keynesian policies require massive amounts of restraint. It required a laser like precession on how the funds are spent. Profitability is the resulting objective. The idea is that we do not want to wait decades to reap the rewards of the expenditure. It requires FULL transparency. These are traits the federal workforce has never been able to demonstrate. The 2005 BRAC – nearing completion this year is a glowing example of what we can expect from the federal workforce. The feds are now underway with more construction that will top $800 per sq. ft for a NIH research and office building in Silver Springs.

When federal policy makers say we are not applying Keynesian principals hard and strong enough – well that is a lie. We have topped out Keynesian economics far more than what it was intended for. Keynesian policies only work when we pay back the debt at a lesser cost than the rewards earned. When we look out over the horizon and see that all current republican proposed budgets still uses deficit spending, the federal government is not ready to stop. The Heritage Foundation and Paul Ryan’s plans both will drive the national debt to over $20 trillion in the next 10 years. The debt service will eclipse the DoD budget by then (if our debt does not go into junk status). We have long passed any positive potential that could be gained out of this egregious spending. The debt was used foolishly and will continue to be used foolishly and the interest will be crippling.

Heritage’s analysis is good. Now they need to apply this warning to the rest of their policies. The only way out is to equate spending to revenue. And that requires a lot of cutting. The sooner we get to it the better for the nation.

You point out that there is no net increase in aggregate demand when government defict spends. You should note that this is the best case scenario. I've seen Heritage writers use the analogy of taking a bucket of water out of one end of a pool, walking to the other end and pouring it back in and expecting the whole water level to rise. Again this is best case. In reality the bucket has leaks in it so while walking around to the other side of the pool water is draining out of the bucket, and as it is poured back in the water level is actually lower than before. This would be the more realistic scenario.

The concept of “Keynesian Economics” must be removed from the study of economics and transferred to the study of history, as is things that consistently failed regardless of the magnitude of the monies applied when tried.

Students at undergraduate courses of macroeconomics should see a footnote indicating that Keynesian Economics was a flawed concept tried by both political parties in America with disastrous results each time. There were only undesired side effects directly relational to the amount of the people’s money wasted in the attempt to stimulate the American economy coupled with false hope and worse change. Students should then be directed to case studies of these instances including the 1930’s Great Depression with all of FDR’s failed fiscal and federal government policies, those attempts of a President Bush and those of BHO’s fake stimulus, underhanded deals with the Federal Reserve Bank, government takeovers and presenting the plethora of false and misleading statements made by his administration concerning virtually everything he (or his administration) said to include the actual results.

Later in the student’s academic pursuits they should be presented with viable solutions to get the economy on the right track. The process of these solutions would include what needs to be done to prevent returning to this same issue over and over again.

While I may have only had a modicum of study in economics and contemporary economic problems, I later learned how to evaluate results and draw conclusions based on other duty related courses and service experience. It is relatively easy to discern if one number is greater than, less than or equal to another number which the positively identifies change and in what direction. The key is to know where to obtain accurate raw information thereby enabling one to remove the smoke and mirrors of politically spun statements and data. If you are not able to obtain such data, or have not been trained in how to use economic formula to determine strength, growth and efficiency of an economy, then you are limited to trusting others to do all of this. I trust Heritage Foundation to get the true economic data and analyze it without politically filtering things in or out; they have no preconceived outcomes but let the evidence speak for itself. This type of integrity is difficult to come by in general and absolutely absent from the Obama administration.

I'm so baffled how anyone can say the stimulus failed, particularly so-called economists. GDP had negative growth before the stimulus and jumped into the positive after passage. We were losing 750,000 jobs a month before stimulus and now create between 50,000-250,000 a month. The stock market has nearly doubled. And somehow, some are able to look at this bill (which had 1/3rd tax cuts, 1/3 spending and infrastructure and 1/3 aid to states) and call it a failure?

The same folks are ones that want to cut spending further right now. These are people with very little economic understanding and zero economic history to stand behind them. They seem to be making the argument that Hooverism works…and did not lead us into the great depression. Hoover argued that we must stop spending when we hit the recession – which is exactly the opposite of what is proven to work.

We had a budget that was balanced in 2001. 10 years ago. We can do it again if we have reasonable and balanced approaches – not this spending cuts alone mentality that will lead us into a 2nd great depression.

Good article and good feedback. I have seen pictures and other articles on some of these new government "palaces" referenced in Mr. Colgroves' feedback. It's frightening what the government spends to create office space in the DC area. Perhaps that is part of the reason that the DC area economy is more "un-touched" than the rest of the country. It seems it's so easy for Washington to spend money we don't have, especially when it's spent in DC's own "neighborhood." Again, frightening!

Let's keep in mind that the $840B went to pay off many Obama Supporters from the 08 Elections like unions. Then there were the state and local governments who needed money to keep people working (remember that Obama was counting job's saved more then job's created). Cincinnati used it's Obama Money to buy new Blackberry's for the Police Departments. I don't know where all the "shovel-ready" projects went, but a good chunk of the money was saved for Obama purposes. I feel that the money spent was more a payoff than an incentive driven policy.

If the policy had any potential for good, it was soon doused by Obama and his "clueless" Administration of intellectuals. How can any business owner or CEO – CFO plan to spend and grow when you are constantly being pounded with tax motivated speeches like "Cap-N-Trade" and an expensive insurance plan is being forced upon you. If you are smart, you will take all the cash you can and "sit on it" which is exactly what has happened.

The Obama election as President had to be the worse situation this country could face, at the worse possible time in its history. That has nothing to do with color and everything to do with results.

For economic & fiscal conservatives like me, this is why we follow the Heritage Foundation. An absolutely fantastic post by Mr. Weinberger giving more teeth to the long-ago established truth: Keynesian policies-the hallmark of progressivism in regards to how to stimulate the economy-are a fundamental failure.

It's amazing how true believers can look at facts and see blue sky where others see storms. Kevin H. interprets the worst recession recovery in the last 70 years as a roaring success, where reasonable thinkers conclude the stimulus is actually retarding the traditional rapid rebound of the American economy (see http://cr4re.com/charts/charts.html for the job loss data vs time). Much of the recovery is illusion – witness half of last months' new employment courtesy of McDonalds! It's clear that billions removed from the private economy to fund governments' grand schemes do nothing to improve the real GDP, but rather succeed in full employment for government employees and political supporters. But in the Keynesians' world, the ditches must be dug only to be refilled so that cash can flow and get multiplied. There is a hugely negative multiplier on the taxpayer side of that equation, and a corresponding long term negative return on investment.

huh. And all this talk about "keep what works" and "change" what doesn't. Does the Keynesian system intentionally create rules of compromise to the free market business as costly obstacles to force collapse like Obama does? Causing more job losses than gained? Where careers disappear while government temporary make work is here?

The only man to trust is a man that lives up to his word with inherent good will…

David Weinberger you really did a wonderful piece! I wish the Democrats could read this, but of course, they Ignore Facts. Oh! Well! But in the end, Keynesian Economics was always Junk Science! This is one on my List of Big Junk, really big Junk Science. Amazing to me the pure blind Faith of the Left Wing Nuts, what never worked, ever, and they still uphold it. George is right, you could have some tiny benefit in certain limited circumstances, but it is Junk Economic Science.

I think the Income Tax is similar. The horrible thing is this Junk Science can last for decades, and fail all the way, and still these buffoons believe it! Why can't people see that Income is not the same as money. The Income Tax just Vanishes Capital! I swear, the Progressives are retarded by their anti God anti Spirit beliefs! I have begun to call Humanism a mental illness because it does so much damage to our culture and to the human mind. Science has never proved God doesn't exist! Same with Evolution: Progressives twisted the words so that Evolution by Natural Selection is held as the exact same thing as Adaptation of Species. But nowhere in the Fossel Record is there an Evolved Species. They just wanted to exploit a non religious explanation, even if it was totally WRONG!

Thanks again Heritage Foundation! You are just killing them in the debate! Hey! Even Bill O'Reilly is climbing on board! Excellent job David, Ed should give you a gold star.

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